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MS Coal is obligated to the State of Virginia to restore leased land to its original condition after its coal mining activities are over in four years. The cash flow possibilities are probabilities for the restoration costs in four years are as follows:

Cash Outflow Probability

$20 million 20%

30 million 40%

40 million 30%

50 million 10%

The company's credit-adjusted risk-free interest rate is 5%.

Required:

Calculate the liability that Santa Cruz must record at the beginning of the project for the restoration costs.

Explanation / Answer

Answer: The expected cash flow is:

$20 million * 20%=4 million

30 million * 40%=12 million

40 million * 30%=12 million

50 million *10%=5 million

Total                 =33 million

Liability =$33 million*PVIF(5%,4)

=$33 million*0.82270

=$27149100

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